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Crestline Capital growing in its own right

Bruce Wardinski doesn't mince words when he describes his company: "We're young, we're aggressive, we're hotel people and we want to grow."

Wardinski is chairman of the board, president and CEO of Bethesda, Md.-based Crestline Capital Corp. (NYSE: CLJ). Created by lodging REIT Host Marriott Corp. (NYSE: HMT) to accommodate its need for a third-party leasing company, Crestline Capital started out as one of the largest and best-capitalized leasing companies in the hotel business, with an initial portfolio of leases on 191 hotels and ownership of 31 senior living communities.

On the horizon, judging by plans that are already taking shape, there's a lot of growth in sight for Crestline Capital. Slated to move out from underneath the Host Marriott umbrella early next year, the company has begun an aggressive program of expanding its portfolio of owned hotels, entering into attractive hotel development deals, and carving out a large niche in the hotel management business through acquisition of existing companies.

Crestline Capital was formed when Host Marriott restructured its business operations to become a REIT. Given the legal prohibition against REITs deriving revenues directly from the operation of hotels, Host Marriott needed to set up a third-party company that could lease its hotel properties. It accomplished this mandate by spinning off Crestline as a separate public company in December 1998.

The deal positioned Crestline Capital as a $350 million company headed by Wardinski, an 11-year Marriott Corp. executive who, at the time, was serving as Host Marriott's senior vice president and treasurer. The company opened up shop with an initial portfolio of leases on 120 full-service hotels, the majority of them managed under the Marriott and Ritz-Carlton brands through long-term contracts with Marriott International.

Holdings also included subleases on 71 limited-service hotels, also managed by Marriott International under the Courtyard by Marriott and Residence Inn brands. On the ownership side, the portfolio included 7,400 units in 31 senior living communities, with most providing a full continuum of facilities, from independent living to health care for the elderly.

It took Crestline a little more than three months to get into the ownership of hotels. In March 1999, the company bought a limited partnership interest in 11 Residence Inns for $89 million. It has also entered the hotel development business with projects in Baltimore and Portsmouth, Va. These forays into ownership "exemplify our investment flexibility," says Wardinski, and are part and parcel of being "an opportunistic real estate company that will continue to pursue attractive growth opportunities in a variety of forms."

This strategy worked well during the company's first year of operation. Crestline's third-quarter 1999 earnings report (the latest available at press time) noted earnings before interest expense, taxes, depreciation and amortization (EBITDA) of $28.6 million, a 50% increase over pro forma 1998 (i.e., the projected performance of Crestline had the company been created in 1998) EBITDA of $19.1 million. Year-to-date (January-October 1999) EBITDA was $82.2 million, a 36% increase over pro-forma 1998 EBITDA of $60.6 billion, with year-to-date diluted earnings of $1.38 per share, compared with 1998's 85 cents per share.

"The company's third-quarter performance was driven by exceptional growth in operating profits by our full-service leased hotels," the report states.

Cash infusion to fuel new directions Recent legislation affecting REIT regulation will have an impact on Crestline Capital. Due to provisions of the REIT Modernization Act that allow REITs to create taxable subsidiaries, Host Marriott's need for a leasing company will cease, putting an end to that part of Crestline's business later this year, he explains.

Bad news? Not really. At the end of this leasing relationship, Crestline gets to pocket some $250 million (pretax) in lease termination fees from Host Marriott. The cash infusion into the already well-capitalized company will allow it to move in some new directions.

"What we want to do is become a more traditional owner/operator of hotels," says Wardinski.

And, at the same time, "We're also eager to enter the hotel management business," he notes. Crestline Capital's immediate goal is to own and/or manage at least 100 hotels by the end of 2001. "We think that this goal is very achievable," says Wardinski.

Take minority positions Crestline will use its formidable financial muscle to invest in the hotel business through acquisition of existing hotels and management companies, particularly smaller, private hotel management organizations, says Wardinski, as well as through developing new properties.

Diversification will be one hallmark of Crestline's investment strategy. "We will be trying to stretch the capital we have by taking minority positions in a number of investments, putting 10% to 20% equity in deals, as opposed to 100%," says Wardinski.

The company will leverage its strength by using borrowed funds for investment. It's a good time to be a buyer in the hotel industry. "We are seeing valuations at historical lows, which makes us think we are getting into this business at exactly the right time," he says.

Upscale investment focus Crestline wants to invest in and/or manage hotel product that reflects its current high-quality, upscale portfolio in urban locations in major markets. Favored brands include full-service Hyatts, Hiltons, Westins and Sheratons and limited-service Courtyards, Hilton Garden Inns, Residence Inns, and Homewood Inns.

Wardinski aims for Crestline to be Host Marriott's preferred management company. In its favor are its Marriott veterans and Crestline's small size, which enables the company to remain nimble. "We can move very quickly," says Wardinski.

For Crestline, he notes, the opportunities in today's hotel marketplace are numerous. "The biggest challenge will be in sorting them out, and making sure that we do the right deals."

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